nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2007‒02‒24
fifteen papers chosen by
Christian Zimmermann
University of Connecticut

  1. Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach By Smets, Frank; Wouters, Rafael
  2. Amplifying Business Cycles through Credit Constraints By Chakraborty, Suparna
  3. Vintage Capital and Expectations Driven Business Cycles By Flodén, Martin
  4. Forming Priors for DSGE Models (and How It Affects the Assessment of Nominal Rigidities) By Del Negro, Marco; Schorfheide, Frank
  5. Transmitting shocks to the economy: The contribution of interest and exchange rates and the credit channel By Edda Claus; ris Claus
  6. Career Progression and Formal versus On-the-Job Training By Adda, Jerome; Dustmann, Christian; Meghir, Costas; Robin, Jean-Marc
  7. Job Creation and Job Destruction over the Life Cycle: The Older Workers in the Spotlight By Jean-Olivier Hairault; Arnaud Chéron; François Langot
  8. Taste for variety and endogenous fluctuations in a monopolistic competition model. By Thomas Seegmuller
  9. Employment fluctuations with downward wage rigidity: the role of moral hazard By James Costain; Marcel Jansen
  10. The Role of Education in Development By Marla, Ripoll; Juan, Cordoba
  11. BEMOD: a DSGE model for the Spanish economy and the rest of the Euro area By Javier Andrés; Pablo Burriel; Ángel Estrada
  12. International Capital Flows By Eric Van Wincoop; Cedric Tille
  13. On the Ramsey equilibrium with heterogeneous consumers and endogenous labor supply. By Stefano Bosi; Thomas Seegmuller
  14. Financing Development: The Role of Information Costs By Jeremy Greenwood; Juan M. Sanchez; Cheng Wang
  15. Financial Integration, Financial Deepness and Global Imbalances By Enrique G. Mendoza; Vincenzo Quadrini; Jose-Victor Rios-Rull

  1. By: Smets, Frank; Wouters, Rafael
    Abstract: Using a Bayesian likelihood approach, we estimate a dynamic stochastic general equilibrium model for the US economy using seven macro-economic time series. The model incorporates many types of real and nominal frictions and seven types of structural shocks. We show that this model is able to compete with Bayesian Vector Autoregression models in out-of-sample prediction. We investigate the relative empirical importance of the various frictions. Finally, using the estimated model we address a number of key issues in business cycle analysis: What are the sources of business cycle fluctuations? Can the model explain the cross-correlation between output and inflation? What are the effects of productivity on hours worked? What are the sources of the “Great Moderation”?
    Keywords: business cycle; DSGE models; monetary policy
    JEL: E4 E5
    Date: 2007–02
  2. By: Chakraborty, Suparna
    Abstract: Theory suggests that endogenous borrowing constraints amplify the impact of external shocks on the economy. How big is the amplification? In this paper, we quantitatively investigate this question in the context of a dynamic general equilibrium model with borrowing constraints under two alternatives: (1) borrowing constraint endogenously depends on the borrower's net worth (2) borrowing constraint is exogenous. Calibrating our model to the Japanese economy, we find evidence of significant amplification in our impulse responses. Quantitatively applying the model to the Japanese case, we find TFP can significantly account for the Japanese business cycle during the period 1980 to 2000 and the impact is much amplified when we assume that borrowing constraints are endogenously determined.
    Keywords: Borrowing constraint; Endogenous; Net worth; Business cycle; Amplification
    JEL: E32
    Date: 2006–12–11
  3. By: Flodén, Martin
    Abstract: This paper demonstrates that increased optimism about future productivity can generate an immediate economic expansion in a neoclassical model with vintage capital and variable capacity utilization. Previous research has documented that standard neoclassical models cannot generate a simultaneous increase in consumption, investment, and hours in response to news shocks, and that optimism in these models tends to reduce investment and hours. When technology is vintage specific, however, expectations of higher future productivity raise the demand for new vintages of capital relative to installed capital. Capital depreciates faster when utilization is high, but this depreciation only affects installed capital. The cost of high depreciation therefore falls when the value of installed capital falls. It is demonstrated here that with standard parameter values, more optimism raises utilization, consumption, investment, hours, and output.
    Keywords: business cycles; capital-embodied technological change; expectations; news; vintage capital
    JEL: E13 E32
    Date: 2007–02
  4. By: Del Negro, Marco; Schorfheide, Frank
    Abstract: In Bayesian analysis of dynamic stochastic general equilibrium (DSGE) prior distributions for some of the taste-and-technology parameters can be obtained from microeconometric or pre-sample evidence, but it is difficult to elicit priors for the parameters that govern the law of motion of unobservable exogenous processes. Moreover, since it is challenging to formulate beliefs about the correlation of parameters, most researchers assume that all model parameters are independent of each other. We provide a simple method of constructing prior distributions for (a subset of) DSGE model parameters from beliefs about the moments of the endogenous variables. We use our approach to investigate the importance of nominal rigidities and show how the specification of prior distributions affects our assessment of the relative importance of different frictions.
    Keywords: Bayesian analysis; DSGE models; model comparisons; nominal rigidities; prior elicitation
    JEL: C32 E3
    Date: 2007–02
  5. By: Edda Claus; ris Claus
    Abstract: Understanding the transmission channels of shocks is critical for successful policy response. This paper develops a dynamic general equilibrium model to assess the relative importance of the interest rate, the exchange rate and the credit channels in transmitting shocks in an open economy. The relative contribution of each channel is determined by comparing the impulse responses when the relevant channel is suppressed with the impulse responses when all three channels are operating. The results suggest that all three channels contribute to business cycle fluctuations and the transmission of shocks to the economy. But the magnitude of the impact of the interest rate channel crucially depends on the inflation process and the structure of the economy.
    Keywords: Transmission channels, open economy, general equilibrium model
    Date: 2007–02–19
  6. By: Adda, Jerome; Dustmann, Christian; Meghir, Costas; Robin, Jean-Marc
    Abstract: We develop a dynamic discrete choice model of training choice, employment and wage growth, allowing for job mobility, in a world where wages depend on firm-worker matches, as well as experience and tenure and jobs take time to locate. We estimate this model on a large administrative panel data set which traces labour market transitions, mobility across firms and wages from the end of statutory schooling. We use the model to evaluate the life-cycle return to apprenticeship training and find that on average the costs outweigh the benefits; however for those who choose to train the returns are positive. We then use our model to consider the long-term lifecycle effects of two reforms: One is the introduction of an Earned Income Tax Credit in Germany, and the other is a reform to Unemployment Insurance. In both reforms we find very significant impacts of the policy on training choices and on the value of realised matches, demonstrating the importance of considering such longer term implications.
    Keywords: administrative data; apprenticeship; dynamic discrete choice; education; job mobility; job search; labour supply; matching; tax credits
    JEL: I2 J6
    Date: 2007–02
  7. By: Jean-Olivier Hairault (EUREQua, University of Paris I, CEPREMAP and IZA); Arnaud Chéron (GAINS, University of Le Mans and EDHEC); François Langot (GAINS, University of Le Mans, CEPREMAP and EUREQua)
    Abstract: This paper extends the job creation - job destruction approach to the labor market to take into account the life-cycle of workers. Forward looking decisions about hiring and firing depend on the time over which to recoup adjustment costs. The equilibrium is typically featured by increasing (decreasing) firing (hiring) rates with age, and a hump-shaped age-dynamics of employment. The empirical plausibility of the model is assessed by incorporating existing age-specific labor market policies in France. Finally we show that the age-dynamics of employment is optimal when the Hosios condition holds and we design the optimal agepattern for employment policies when this condition does not apply.
    Keywords: job search, matching, life cycle
    JEL: J22 J26 H55
    Date: 2007–02
  8. By: Thomas Seegmuller (Centre d'Economie de la Sorbonne)
    Abstract: In past years, imperfect competition has been introduced in several dynamic models to show how mark-up variability, increasing returns (decreasing marginal cost) and monopoly profits affect the occurence of endogenous fluctuations. In this paper, we focus on another possible feature of imperfectly competitive economies : consumers' taste for variety due to endogenous product diversity. Introducing monopolistic competition (Dixit and Stiglitz (1977), Benassy (1996)) in an overlapping generations model where consumers have taste for variety, we show that local indeterminacy can occur under the three following conditions : a high substitution between capital and labor, increasing returns arbitrarily small and a not too elastic labor supply. The key mechanism for this result is based on the fact that, due to taste for variety, the aggregate price decreases with the pro-cyclical product diversity which has a direct influence on the real wage and the real interest rate.
    Keywords: Endogenous fluctuations, taste for variety, imperfect competition.
    JEL: C62 D43 E32
    Date: 2007–01
  9. By: James Costain (Banco de España); Marcel Jansen (Universidad Carlos III de Madrid)
    Abstract: This paper considers a dynamic matching model with imperfectly observable worker effort. In equilibrium, the wage distribution is truncated from below by a no-shirking condition. This downward wage rigidity induces the same type of inefficient churning and "contractual fragility" as in Ramey and Watson (1997). Nonetheless, the surprising lesson of our analysis is that workers' shirking motive reduces the cyclical fluctuations in job destruction, because firms are forced to terminate some marginal jobs in booms which they cannot commit to maintain in recessions. This time-inconsistency problem casts doubt upon the importance of inefficient churning as an explanation of observed employment fluctuations. On the other hand, the no-shirking condition implies that firms' share of surplus is procyclical, which can amplify fluctuations in job creation. Thus, our model is consistent with recent evidence that job creation is more important than job destruction in driving labor market fluctuations. Furthermore, unlike most models with endogenous job destruction, we obtain a robust Beveridge curve.
    Keywords: job matching, wage rigidity, efficiency wages, contractual fragility
    JEL: C78 E24 E32 J64
    Date: 2006–11
  10. By: Marla, Ripoll; Juan, Cordoba
    Abstract: Most education around the globe is public. Moreover, investment rates in education as well as schooling attainments differ substantially across countries. We construct a general equilibrium life-cycle model that is consistent with these facts. We provide simple analytical solutions for the optimal educational choices, which may entail pure public provision of education, and their general equilibrium effects. We calibrate the model to fit cross-country evidence on demographics and educational variables. The model is able to replicate a number of key regularities in the data beyond the matching targets. We use the model to identify and quantify sources of world income differences, and find that demographic factors, in particular mortality rates, explain most of the differences. We also use the model to the role of public education and the HIV/AIDS pandemic in development.
    Keywords: education; human capital; development; public education; income differences
    JEL: I22 J24 O11
    Date: 2006–09
  11. By: Javier Andrés (Banco de España; Universidad de Valencia); Pablo Burriel (Banco de España); Ángel Estrada (Oficina Económica de Presidencia del Gobierno)
    Abstract: In this paper we present the theoretical foundations and the simulation results obtained with a new dynamic general equilibrium model developed at the Banco de España for the Spanish economy and the rest of Euro area. The model is designed to help in simulating the effect of alternative shocks on the main aggregate variables. The main contributions of this work from a theoretical perspective are the modelling of a monetary union composed of two regions, the inclusion of housing as a durable good with its own sector of production and the degree and detail of the disaggregation considered for each country in the model, which replicates the Quarterly National Accounts. On the empirical side, the main contribution is the detailed calibration of the most important ratios of the Spanish and rest of the Euro area economies.
    Keywords: sdge model, open economy, simulation, shocks, macroeconomic policies
    JEL: E32 E50 F41
    Date: 2006–11
  12. By: Eric Van Wincoop; Cedric Tille
    Abstract: The sharp increase in both gross and net capital flows over the past two decades has led to a renewed interest in their determinants. Most existing theories of international capital flows are in the context of models with only one asset, which only have implications for net capital flows, not gross flows. Moreover, there is no role for capital flows as a result of changing expected returns and risk-characteristics of assets as there is no portfolio choice. In this paper we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. We show why standard first and second-order solution methods no longer work in the presence of portfolio choice, and extend them giving special treatment to the optimality conditions for portfolio choice. We apply the solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach highlights time-varying portfolio shares, resulting from time-varying expected returns and risk characteristics of the assets, as a potential key source of international capital flows.
    JEL: F32 F36 F41
    Date: 2007–01
  13. By: Stefano Bosi (EQUIPPE - Université de Lille 1 et EPEE); Thomas Seegmuller (Centre d'Economie de la Sorbonne)
    Abstract: In this paper, we address the question of deterministic cycles in a Ramsey model with heterogeneous infinite-lived agents and borrowing constraints, augmented to take into account the case of elastic labor supply. Under usual restrictions, not only we show that the steady state is unique, but also we clarify its stability properties through a local analysis. We find that, in many cases, the introduction of elastic labor supply promotes convergence by widening the range of parameters for saddle-path stability and endogenous cycles can eventually disappear. These results are robustly illustrated by means of canonical examples in which consumers have separable, KPR or homogeneous preferences.
    Keywords: Saddle-path stability, endogenous cycles, heterogeneous agents, endogenous labor supply, borrowing constraint.
    JEL: C62 D30 E32
    Date: 2007–01
  14. By: Jeremy Greenwood (University of Pennsylvania); Juan M. Sanchez (University of Rochester); Cheng Wang (Iowa State University)
    Abstract: How does technological progress in financial intermediation affect the economy? To address this question a costly-state verification framework is embedded into a standard growth model. In particular, financial intermediaries can invest resources to monitor the returns earned by firms. The inability to monitor perfectly leads to firms earning rents. Undeserving firms are financed, while deserving ones are under funded. A more efficient monitoring technology squeezes the rents earned by firms. With technological advance in the financial sector, the economy moves continuously from a credit-rationing equilibrium to a perfectly efficient competitive equilibrium. A numerical example suggests that finance is important for growth.
    Keywords: financial intermediation, economic development, costly state verification
    JEL: E13 O11 O16
    Date: 2007–03
  15. By: Enrique G. Mendoza; Vincenzo Quadrini; Jose-Victor Rios-Rull
    Abstract: Large and persistent global financial imbalances need not be the harbinger of a world financial crash. Instead, we show that these imbalances can be the outcome of financial integration when countries differ in financial markets deepness. In particular, countries with more advanced financial markets accumulate foreign liabilities in a gradual, long-lasting process. Differences in financial deepness also affect the composition of foreign portfolios: countries with negative net foreign asset positions maintain positive net holdings of non-diversifiable equity and FDI. Abstracting from the potential impact of globalization on financial development, liberalization leads to sizable welfare gains for the more financially-developed countries and losses for the others. Three empirical observations motivate our analysis: (1)financial deepness varies widely even amongst industrial countries, with the United States ranking at the top; (2) the secular decline in the U.S. net foreign asset position started in the early 1980s, together with a gradual process of international capital markets liberalization; (3) net exports and current account balances are negatively correlated with indicators of financial development.
    JEL: E21 F3 F32 F41
    Date: 2007–02

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